Explain the concept of sensitivity coefficient in capital budgeting.

The concept of sensitivity coefficient in capital budgeting refers to the measure of the impact that changes in a particular variable have on the overall profitability or feasibility of a capital investment project. It is used to assess the sensitivity or responsiveness of the project's net present value (NPV) or internal rate of return (IRR) to changes in key variables such as sales volume, cost of capital, inflation rate, or any other relevant factor.

The sensitivity coefficient is calculated by determining the percentage change in the NPV or IRR resulting from a given percentage change in the variable of interest. It helps decision-makers understand the potential risks and uncertainties associated with the project by quantifying the extent to which changes in key variables can affect the project's financial performance.

By analyzing the sensitivity coefficients of different variables, managers can identify the most critical factors that significantly impact the project's profitability. This information allows them to prioritize their focus on managing and mitigating the risks associated with these variables. Sensitivity analysis helps in making informed decisions, as it provides insights into the potential outcomes under different scenarios and assists in determining the robustness and flexibility of the investment project.

Overall, the sensitivity coefficient in capital budgeting is a valuable tool that aids in evaluating the sensitivity of a project's financial metrics to changes in key variables, enabling decision-makers to assess the project's risk profile and make informed investment decisions.